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DeMarche The Five Key Sources of Stock Returns Bob Duwa DeMarche Associates, Inc. CFA Nebraska February 18, 2009.

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Presentation on theme: "DeMarche The Five Key Sources of Stock Returns Bob Duwa DeMarche Associates, Inc. CFA Nebraska February 18, 2009."— Presentation transcript:

1 DeMarche The Five Key Sources of Stock Returns Bob Duwa DeMarche Associates, Inc. CFA Nebraska February 18, 2009

2 DeMarche 1 The Five Key Sources of Stock Returns Key Factor Groups DeMarche Phase Analysis Market Outlook

3 DeMarche 2 Key Factor Groups

4 DeMarche 3 Forces Affecting Stock Return The Economy Market Behavior Industry Outlook Stock Price Company Characteristics and Issues

5 DeMarche 4 Five Factor Groups Investment Style Factors Dividend yield, book to price, earning yield Firm Factors EPS growth, ROE, asset turnover, profit margin, debt level Industry Factors Competition, regulation Liquidity Factors Trading volume and change in volume, share price, cap size Momentum Factors Short, intermediate and long-term price history

6 DeMarche 5 Key Factor Groups Providing Highest Sources of Alpha Valuation Risk Growth Industry Momentum Liquidity “Style”

7 DeMarche 6 DeMarche Style Factors – Growth/Value

8 DeMarche 7 Style Leadership – Growth/Value

9 DeMarche 8 FAMA Style Indexes Annualized Returns

10 DeMarche 9 DeMarche Style Factors - Quality

11 DeMarche 10 Style Leadership - Quality

12 DeMarche 11 Firm Factors Profitability (ROE) EPS Growth Dividend Growth Asset Turnover Profit Margin Debt Level

13 DeMarche Total Company Count Defensive-AggressiveValue-Growth Topography of the Market Company Count vs. Growth / Value and Aggressive / Defensive D A G V D A G V Total Company Count Defensive-AggressiveValue-Growth Topography of the Market Company Count vs. Growth / Value and Aggressive / Defensive

14 DeMarche 13 D A G V 0% 2% 4% 6% 8% 10% 12% Percent of Total Market Cap Defensive-AggressiveValue-Growth Topography of the Market Market Cap vs. Growth / Value and Aggressive / Defensive D A G V 0% 2% 4% 6% 8% 10% 12% Percent of Total Market Cap Defensive-AggressiveValue-Growth Topography of the Market Market Cap vs. Growth / Value and Aggressive / Defensive

15 DeMarche 14 Valuation Basis Points Formulas R-squared per Ventile Price to Book80%34 Price to Cash Flow73%35 Earnings to Price33%23 Earnings Surprise & Revisions3%4 CAPM5%-5 Source: DeMarche Associates, One-Year Return Predictability of Various Valuation Formulas

16 DeMarche 15 Basis Points Metrics R-squared per Ventile Asset Utilization (Turns)48%27 Free Cash Flow Return on Investment41%21 ROE40%11 EVA32%13 Cash Flow Return on Investment12% 7 ROA 0% 2 Source: DeMarche Associates, One-Year Return Predictability of Various Metrics

17 DeMarche 16 Lakonishok Study ( ) Percentage of Firms with ABOVE-MEDIAN Growth in Operating Income for Number of Years Years Predictability? Companies Change!

18 DeMarche 17 DeMarche Study ( ) (Lakonishok Method) Percentage of Firms with ABOVE-MEDIAN Growth inStock Returnsfor Number of Years Years Years Predictability? Companies Change!

19 DeMarche 18 Focus time on holdings with worst expected return potential to avoid “bombs” Identify sell signals Quantify basis for shifts in industry bets Add value in tilt decisions on growth/value or aggressive/defensive spectrum Benefits for Portfolio Managers

20 DeMarche 19 Benefits for Clients & Consultants Better understanding of investment process Improve communication between client, manager, and consultant

21 DeMarche 20 DeMarche Phase Analysis

22 DeMarche 21 Probability Distribution of Three-Year S&P 500 Returns 1929 – December 31, 2008

23 DeMarche 22 Market Phase Analysis 1/1/63 to 12/31/ % 19.2% -15.4% 9.4%

24 DeMarche 23 Drivers of Stock Price – Bull Market One-Year Return Predictability of Various Metrics Basis Points Metrics R-Squared per Ventile ROE 31% 13 Asset Utilization 27% 17 Free Cash Flow Return on Investment 20% 12 EVA SM 9% 8 ROA 0% - 1 Source: DeMarche Associates,

25 DeMarche 24 Drivers of Stock Price – Bear Market One-Year Return Predictability of Various Metrics Basis Points Metrics R-Squared per Ventile Asset Utilization 41% 73 Free Cash Flow Return on Investment 32% 65 EVA SM 27% 39 ROA 4% 13 ROE 0% 0 Source: DeMarche Associates,

26 DeMarche 25 Style Leadership by DeMarche Market Phase Style Leadership Phase I Small Cap Growth Phase IILarge Cap Growth Phase IIISmall Cap Value Phase IV Large Cap Value

27 DeMarche 26 Benefits for Clients & Consultants Better understanding of manager returns and periods of expected bad performance Tactical Restructuring

28 DeMarche 27 DeMarche Market Outlook

29 DeMarche 28 Discretionary Management Services, LLC Forecast 2009 Jan 1 - Dow 8776 Dec 31 - ??? --- Back to 8776 ? 1st Quarter - Test 7450 low If broken, seeks support below 7000 By Labor Day - Dow tries to break 10,000 1 st Quarter2 nd Quarter3 rd Quarter4 th Quarter

30 DeMarche 29 3-Yr. Equity Returns? Price/Earnings ratio represents the month-end index closing price divided by 12-months quarterly as reported diluted earnings per share (GAAP EPS). As of 12/31/08, nine months of actual reported earnings and three months of estimated earnings were used. Averages Since 1936: P/E Mo. Earnings Growth Rate 7.3%

31 DeMarche 30 3-Yr. Fixed Income Returns? Projected bond returns shown above make no assumption about potential default or recovery rates.

32 DeMarche 31 Man is not a rational being, man is an animal that rationalizes! Source Unknown

33 DeMarche 32 DeMarche Associates


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